Investment Road Test: Brookfield Mortgage Bonds

PORTFOLIO POINT: Secured against a Sydney building leased to the federal government, this product is a relatively simple and high-yielding investment.

If you believe the global financial crisis is behind us, then this one is for you. Brookfield Multiplex has issued an innovative mortgage-backed bond, which is secured over a Commonwealth government tenanted property in the Sydney CBD.

The Brookfield Bonds are ASX-listed and pay an enhanced fixed income return. The primary risk at the end of the three-year bond term is that the issuer will have to refinance the debt to fund their redemption. Given the quality of the underlying property, this will not be problematic – so long as the debt markets are open at that time.

For these types of instruments the yield is typically not the issue (so long as investment is correctly structured, which we assess below), it’s the exit mechanism: as holders of many of the Babcock & Brown and Allco-sponsored investments such as Allco HITS will attest.

Unlike structured finance bonds, which contain hard-to-assess cash flows and assets, the Brookfield Bonds are a relatively simple and high-yielding investment, without the usual baggage of mortgage-backed securities.

The problem with mortgage funds such as Westpoint and MFS was the pooling of myriad underlying properties and mortgages, with cash flows linked not just to mortgage payments but also to uncertain default rates and property values.

The Brookfield Bonds are secured against just one asset, the Latitude East building in Goulburn St, Sydney, in which the issuer has a 50% stake. The building has a 13 year lease to the Commonwealth government, so the key assessment for this investment relates to the structure of the bonds and the return they pay.

The ASX code for the Brookfield Bonds is BZAHA, and at the last traded price of $102 the return is still at attractive levels.

The issuer is a special purpose subsidiary of Brookfield Multiplex, the entity that includes the Multiplex group, acquired by US firm Brookfield Asset Management in 2007. Rather than being an accounting creation for deceptive purposes, this special purpose vehicle ensures that rent and security is ring-fenced to the high-quality property and tenant, easing the assessment of the likelihood of receiving the bond’s expected returns.

Security for the bonds is limited in recourse to the underlying property; that is, there is no recourse to the parent company. To further improve bondholders’ security, the rent from the property is held in a segregated account to ensure it is paid to investors.

The return on the bonds was fixed as a margin of 3.25% over the bank bill rate prevailing at the issue date, following an institutional book-build and margin-setting process. (Not that investors automatically should take comfort from institutional price setting – recall the absurdity of institutions agreeing to a margin of only 135 basis points over swap for the Orica hybrid issued at the peak of the bull market – only weeks after Westpac priced a similar hybrid at only 105 basis points over swap.) The rate payable for the Brookfield Bonds is 7.82%.

The underlying property was valued on April 30, 2009, and that would have to give a price tag at the bottom of the cycle. The issuer’s stake of 50% was valued at $95 million, implying a 60% loan-to-valuation ratio for the Brookfield Bonds. The issuer can redeem the bonds early but there are cash penalties payable to bond holders if that occurs.

ASX listing means investors can potentially exit prior to the three-year maturity of the bonds, or they can wait until maturity. The key risk is that the issuer is unable to refinance the debt that the bonds secure but with conservative valuations and the blue-chip tenant, this is remote. The fixed return will be value-eroded in the rising interest rate environment expected, but is still appropriate for the investment risk and quality.

The score: 4 stars
0.5 Ease of understanding/transparency
0.5 Fees/Return
1 Performance/durability/volatility/relevance of underlying asset
1 Regulatory profile/risks
1 Innovation

Tony Rumble is the founder of the ASX-listed products course LPAC Online, a provider of investment training to financial services professionals.